Introduction
Debt forgiveness by parent

Cash contribution into capital surplus
Reduction and subsequent increase of nominal share capital
Comment



Introduction

At the end of 2010 the federal tax authorities issued Circular 32 on restructuring measures. Although Switzerland has not been affected by the global financial crisis to the extent that other countries have, the circular provided welcome guidelines for assessing the tax consequences of debt forgiveness programs and mergers in the context of a loss-making Swiss company. The circular is not all-inclusive since it does not address, for example, the tax consequences of cash contributions, reductions and subsequent increases in nominal share capital, or the sale or segregation of underperforming assets in a spin-off or asset sale.

This update presents a case study of a hypothetical, non-Swiss resident parent company which wholly owns a loss-making Swiss subsidiary. It considers the tax consequences of the use of debt forgiveness, cash contributions into reserves and reductions and subsequent increases of the nominal share capital as financial restructuring measures.

Debt forgiveness by parent

In a debt forgiveness programme, the creditor fully or partially waives a debt (eg, a loan or a current account position) owed by a debtor. Taking the simplified example of debt forgiveness by a foreign parent in favour of its Swiss subsidiary, the following points can be made in relation to corporate income tax, stamp issuance duty and value-added tax (VAT) consequences for the Swiss subsidiary.

Corporate income tax
In general, the Swiss subsidiary is based on its Swiss financial statements subject to corporate income tax at the federal, cantonal and communal level. The overall ordinary effective tax rate, not considering any special regimes, varies from canton to canton between 13% and 26%.

Under Swiss income tax law, contributions to the equity of a Swiss subsidiary are not taxable, even if, for accounting purposes, extraordinary income is shown (ie, tax treatment does not reflect accounting treatment). Therefore, the question is whether a waiver of a debt by the foreign parent in favour of its Swiss subsidiary is, for income tax purposes, a contribution into the equity of the Swiss subsidiary. Such income tax-neutral treatment is accepted by the tax authorities only where:

  • the forgiven debt must be considered to be hidden equity under Swiss thin capitalisation rules; or
  • the debt was granted at a time when an independent third party would not have granted such debt on the same terms.

The benefit of an income tax-neutral treatment of debt forgiveness is that the recapitalised subsidiary can still use tax loss carry-forwards incurred in the previous years. In other words, future profits of the Swiss subsidiary can still be neutralised by such carry-forwards even if the Swiss financial statements no longer show such losses due to the forgiveness of the booked debt.

Where the debt forgiveness does not qualify as a tax-neutral capital contribution for income tax purposes, it must be considered extraordinary income (also for tax purposes). In many cases, such income can be offset against losses incurred (potentially including unused tax losses that were incurred more than seven years ago), so that no income taxes are triggered.

This means that debt forgiveness, which is not considered an income tax-neutral capital contribution, is less advantageous than, for example, cash contributions, since tax losses are used up.

Stamp issuance duty
The question arises as to whether debt forgiveness by the foreign parent constitutes an equity contribution which has not been published in the company register and is therefore subject to 1% stamp issuance duty (also known as 'stamp issuance tax').

Since January 2009 a one-off exemption from such stamp issuance duty has applied to financial restructurings up to Sfr10 million in favour of a loss-making Swiss subsidiary. Furthermore, if a debt forgiveness programme exceeds Sfr10 million, an over-indebted Swiss subsidiary may be entitled to a remission of stamp issuance duty if:

  • the Swiss subsidiary's share capital is no longer covered by assets;
  • no open or hidden reserves are available at the level of the Swiss subsidiary to cover the losses;
  • the debt forgiveness eliminates the incurred losses; and
  • the financial restructuring of the Swiss subsidiary has not been required as the result of previous under-capitalisation or hidden dividend distributions.

VAT
Unfortunately, the possible negative VAT consequences of a debt waiver are not addressed in the circular and therefore are often not considered by tax advisers.

Where debt which resulted from the supply of services or goods is waived, certain questions arise. Has the Swiss subsidiary benefited in any way from a reduced price? If it has benefited from debt forgiveness, is it prevented from reclaiming input VAT which it initially reclaimed from the Swiss VAT authorities (ie, must it make an input VAT adjustment and repay part of the input VAT)? In its reasonable to infer that such adjustment should be required only if supplies by the waiving party to the Swiss subsidiary were initially overpriced.

Debt forgiveness also raises the question of whether a general input VAT reduction should be considered because part of the output is financed by such a waiver. Without an input VAT correction the Swiss subsidiary can reclaim more input VAT than it has to pay output VAT. Based on the new VAT Act 2010, such debt forgiveness in itself should clearly no longer lead to input VAT reductions, provided that the Swiss subsidiary makes such input VAT claims based on its ordinary business activities.

Cash contribution into capital surplus

A common restructuring measure is a cash contribution into the capital surplus without issuing additional shares.

Corporate income tax
A cash contribution of the foreign parent into the capital surplus of its wholly-owned Swiss subsidiary has no corporate income tax consequences for the Swiss subsidiary being recapitalised, since under Swiss income tax law such contribution to the equity of the Swiss subsidiary is tax neutral. The entire tax loss carry-forwards at the level of the Swiss subsidiary continue to be available and can be offset against future profits.

Stamp issuance duty
As with debt forgiveness, in relation to cash contributions by the foreign parent, the question of whether such contributions are subject to 1% stamp issuance duty arises. The Sfr10 million exemption threshold for a loss-making company also applies. If an amount exceeding Sfr10 million to an over-indebted company is paid, in most cases a remission of the stamp issuance duty applies so that it need not be paid.

VAT
In line with the treatment of debt forgiveness, parties must asses whether the cash contribution constitutes a factual reduction of the consideration paid for overpriced services or goods supplied to the Swiss subsidiary and which could lead to a reduction of the input VAT claim. Where this is the case, no input VAT reduction need be considered.

Reduction and subsequent increase of nominal share capital

A third way in which a Swiss company can be recapitalised is by making a nominal share capital reduction without repayment of capital to the shareholders, followed by a share capital increase wherein shareholder pays in new capital against newly issued shares. Such a procedure must be notarised and published in the company register.

Corporate income tax
A capital reduction followed by a capital increase has no corporate income tax consequences for the Swiss subsidiary, as it is an open contribution to its equity. The entire tax loss carry-forwards therefore continue to be available and can be offset against future profits.

Stamp issuance duty
A reduction and subsequent increase in the nominal share capital paid by the foreign parent raises the question of whether such increases constitute open equity contributions and are therefore subject to 1% stamp issuance duty. In many cases the Sfr10 million exemption – or if an exceeding amount is paid, the stamp issuance duty remission – applies so that no stamp issuance duty must be paid.

VAT
As a general rule, a nominal share capital reduction followed by an increase does not raise input VAT reduction issues.

Comment

Where a loss-making Swiss company requires financial restructuring, the best measure to be taken depends on the specific circumstances.

From a Swiss tax point of view, a cash contribution into the capital surplus is a valid method of recapitalising the Swiss subsidiary. Where the company is held by more than one shareholder, in principle the amount corresponding to the respective future profit entitlements should be contributed. Where such equal contribution is impossible, a reduction and subsequent increase in the nominal share capital should be considered. Such a measure is relatively expensive, as it requires notarisation of the general assembly decisions. Debt forgiveness should be considered only in circumstances in which it does not use up tax losses.

For further information on this topic please contact
Harun Can or Michael Nordin at Schellenberg Wittmer by telephone (+41 44 215 52 52) or email ([email protected] or [email protected]).